A college education costs a lot of money. Using student loans to pay for could cost you a whole lot more.
The average college graduate in 2016, who took out student loans, owes $37,172, a 6% increase from 2015. That is a sizeable, unwelcome gift to take home from school and it’s important to know how to minimize the damage.
The good news is that federal loans carry a six-month grace period so there is time to develop a plan for dealing with them. One of the best places to start looking is the federal Direct Consolidation Loan program.
If you did borrow money for college, chances are you received a new loan each semester. It is not unusual to owe money to 8-10 separate lenders, maybe more if you had a combination of private and federal loans. If you continue borrowing for graduate school, it’s easy to add another 4-6 lenders to the mix.
Each one of these student loans has its own due dates, interest rates and payment amounts. Keeping track of that many payments is complicated and part of the reason that 8 million Americans have defaulted on over $130 billion in student loans
That is why student loan consolidation appears as such an attractive solution, but there are things you should know as you consider this approach.
The definition of loan consolidation in a nutshell, is this: One loan, one payment, one lender.
It’s simple, efficient and practical, but there are some negatives, not the least of which is that you could end up paying much more in interest by the time you’re finished.
Pros of Direct Loan Consolidation
Here are pros to consider before choosing:
- One payment. Consolidation means combining all your federal loans into one. That loan will be serviced by one lending institution and requires one monthly payment. If you still send payments through the mail, this will save you some money on stamps and envelopes, not to mention saving a whole lot of time and aggravation.
- Avoid default. Consolidating loans will allow you to change the terms and lower your monthly payment. This should help avoid default if you are struggling to make your payments each month. If you default, your credit score will take a major hit, and it remains on your credit report for seven years.
- Fixed interest rate. If you have a lot of loans, you probably have a lot of different interest rates. A consolidated loan has a fixed rate for the life of the loan. The interest rate on a consolidated loan is based on the average of the interest rates on all the loans being consolidated, rounded up to the nearest one-eighth of 1%.
- Lower payments. Consolidation offers a variety of repayment plans, most of which extend the terms of the loan from 10 years to 15, 20 or even 30 years. A longer term loan can lower the monthly payment by as much as 50%, making it more affordable while you get going in the working world. It’s also possible to get reduced interest rates and that too will reduce monthly payments.
- Multiple repayment plans. A Federal Consolidated Loan is eligible for a number of repayment plans and borrowers are free to choose the plan that best suits their situation. Borrowers also can switch repayment plans at any time. Repayment plans for Federal Consolidated Loans include: Standard (10 years), Extended (25 years), Graduated (start low, increase every two years for between 10 and 20 years) and Income-based (10-15% of your discretionary income).
- Deferment/forbearance options increase. Because a Direct Consolidation Loan is a new loan, it restarts the clock on deferments and forbearance for up to three years. Also, if you can’t repay a Federal Consolidation Loan because you are looking for a job, you can apply for unemployment or economic hardship deferment and delay paying for up to three years.
- No minimum or maximum. There is no minimum amount to qualify and no maximum amount that can be consolidated.
- Protecting credit. Consistent payment of student loans has a positive impact on your credit score. Missing just one payment will hurt your credit score. Paying one bill per month instead of 10-15 should lessen the chance of negligence. Avoiding default, as mentioned above, will help protect your credit score as well.
- Automatic debit. If the only reason you’re consolidating is because you can’t keep up with monthly payments to multiple lenders, set up an automatic debit from your bank account to pay the bill every month and be done with it. Just be sure that account is well funded every month.
- Loan discount. Some banks offer discounts on your interest rate if you set up an automatic debit. A few were offering 1% discounts on interest rates after 36 months of on-time payments for as long as the on-time payments continued.
Cons of Student Loan Consolidation
Here are cons to consider before choosing:
- Pay more in interest over time. If you consolidate and extend the loan term, you could pay a lot more in interest. The longer you wait to pay off the loan, the more interest you end up paying. Also, if you’re still paying on a student loan for 20-25 years, it could hinder or even block opportunities to buy a home, relocate to a new city, invest in a business or even purchase a new automobile. Pay off the loan as quickly as possible to save time and money. It’s as simple as that.
- Rounded-up interest rate. Direct loan consolidation adds one-eighth of 1% to the weighted average interest rate. The new rate is determined by a weighted average of all the other rates, which considers the amount owed, and adding 0.125%. If your larger loans have a higher rate, then the weighted average will be a little higher than a simple average.
- No private loan consolidation. Student loans from private lenders or institutions can’t be part of the Federal Consolidation loan program. On the other hand, certain private lenders allow loan consolidation that could include federal loans, but the interest rates are usually much higher on private consolidations.
- Lose some benefits. Some federal loans, notably Perkins Loans, have loan cancellation if you meet certain requirements. Those benefits could go away if you consolidate the loan. For example, police, firefighters and teachers can have 100% of a Perkins loan forgiven, if they meet certain conditions. That opportunity could go away if the Perkins loan becomes part of a Federal Direct Consolidation Loan. Read all the terms and conditions of your loan before consolidating.
- Lost “grace” period. Borrowers typically get a six-month window before having to start repaying student loans. That goes out the door when you consolidate your loans. You typically start paying two months after your loan consolidation is approved.
- Lender benefits gone. Some lenders give reduced interest rates or principal reductions if borrowers meet certain conditions. Those benefits are lost when your student loans are consolidated.
- No do overs. You can only consolidate student loans one time. If interest rates fall after you consolidate, tough break! You’re stuck with the interest rates you agreed to during consolidation.
There is no hard and fast rule about student loan consolidation, other than be sure to do your research. Consolidation is a great option to make your payments more manageable and maybe even save some money. However, it may end up costing you more money in the long run.